Capitalism is an economic system in which there exists private exploitation. In such system, the individuals who produce the surplus labor are not the persons who first receive it or distribute it (Henry, 2014). Communism, on the other hand, is an economic system in which the production, receipt, and distribution of surplus labor are socially arranged (Henry, 2014).
There are many differences between communism and capitalism. The differences can be determined using some indexes proposed by European Bank for Reconstruction and Development (EBRD). According to EBRD, capitalism can be differentiated from communism using eight dimensions. These aspects include price liberalization, trade and foreign exchange liberalization, large-scale privatization, small-scale privatization, enterprise restructuring, competition policy, banking reform, and reform of securities markets and nonbank financial institutions.
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Price liberalization is one of the indices that can be used to distinguish between capitalism and communism. Communism regulates the consumer prices, whereas capitalist liberalizes consumer prices. Before disintegration of Comecon bloc, communist traders used to have problems selling their products and services. The government regulated the prices and services. However, following the disintegration of the Comecon bloc and explosion of macroeconomic crises, the communist leaders were left without the option to control prices and trade as before (Balcerowicz, 1994). By the end of the 1980s, communist economies had a high level of imbalances. This imbalance was worsened by the falling world oil prices. The drop in oil prices undercut the Soviet Union’s export revenue and diminished its ability to support other communist-bloc countries (Balcerowicz, 1994). Communist economies resorted to printing money to cover the budget deficits, which had skyrocketed. The consumer prices, during that time, remained fixed or heavily regulated. The only thing that was provided for free is social services. The policy of printing the money overloaded economies with money that could not be redeemed for goods or services. This idea resulted in "monetary overhang" (Balcerowicz, 1994). During this period, the capitalist economies were progressing well. The consumer prices in such countries were free. The explosion of macroeconomic crisis compelled the communist leaders to liberalize the pricing of products and services. Russia is among the countries which started freeing prices of goods and services. The rest of the Soviet states found it hard to keep costs controlled. They began adopting capitalist pricing system. Most price controls were removed, and energy prices were adjusted to reflect cost.
Trade and foreign exchange liberalization
The ease with which people can invest and trade is one of the key economic index used to distinguish capitalism economies from communism economies. Communist economies have rigid, regulated and controlled trade and foreign exchange system (Balcerowicz, 1994). In such communism, there exist only central planning from the government. Any form of market mechanisms is not allowed. The government control the production, pricing wages, investment and external trade (Balcerowicz, 1994). The government monopolizes trade. Communist economies have closed trade regime. As a result, the level of competition is very low. The closed trade system had an enormous impact in the Communist nation.
Capitalist economies, on the other hand, have open, liberalized internal and external trade. They have no quantitative restrictions on imports and exports. In most capitalist economies, exports are not subject to any export taxes, fees or other barriers. Imports are not subject to any import duty taxes other than customs duties. In fact, the only tariff barriers include tariffs, VAT and excise taxes. As a result of this, the total trade volume is higher among the capitalist economies than the communist economies. Capitalism economies also do not have business investment measures.
Privatization is another index used to distinguish capitalism from communism. Privatization entails giving state-owned corporation to the private firms or private investors. It is one way of improving efficiency and reducing corruption.
Capitalism economies are characterized by large-scale privatization. Most of the state-owned organizations are given to private investors to manage. The privatization process in Western countries is very simple. It does not require an ad hoc legal framework. Capitalism economies are characterized by the existence of markets for corporate control, financial markets, stock exchange, etc. (Balcerowicz, 1994). Transfer of ownership and oversight of the performance of managers and firms is easy. A quick and complete transfer of the property of all existing assets to private hands is only one possible way of expanding the share of the private sector in the economy. The price is the key factor used to determine who is going to exchange partner in transaction on the capital market. The private firm or investor willing to buy a given company or business at a higher price is likely to win the ownership. The reason why capitalism economies outperform communism economies is that the transfer of property rights from the state to the private sector creates better incentives for efficiency and discipline of workers and managers (Balcerowicz, 1994). Privatization in capitalist economies is effected in parallel with an increase in competition and degree of regulation of the economic system (Balcerowicz, 1994). Compared to state-owned firms, private companies in developed market economies tend to have superior corporate governance via the role of external owners in monitoring managerial performance. Managers in private enterprises have the motivation to improve corporate value. They operate in managerial markets that reward efficiency and punish poor performance and payment schemes that align managerial and owners’ incentives. Another aspect that makes privatized economies superior is because managers face the threat of hostile takeovers whereby poorly functioning managers can be replaced through competitive bids by alternative teams. This threat makes most managers of a private firm to be productive and innovative.
Communism economies, on the other hand, have hyper-centralized command system whereby most of the assets are controlled by the state or government. The ownership rights of the property by the state has limited most of the communist nations from excelling economically. State-ownership is characterized by monopoly, lack of competition, limited growth and production of low-quality products. The level of efficiency in economies where assets are owned and managed by the state is usually subtle. This is why communism state failed and opted for mass privatization as a way of reviving their failed economies.
Business restructuring comprises of measures taken to improve the efficiency and effectiveness of a company. One step taken to restructure a business is privatization. Private firms and investors are profit-oriented, and hence they do everything they can to ensure that the level of productivity is high. The standard of enterprise restructuring in communism is very small.
Initially, central government governed communism enterprises. It was hard to restructure such enterprises according to the nature of the market environment. Because of the low level of enterprise restructuring, communism economies exhibit features such as lack of free foreign exchange markets, negative interest rates, high tax burden, widespread quasi-fiscal activities and barter operations, and increasing final product inventories (Balcerowicz, 1994).
Capitalism economies, on the other hand, have a high level of enterprise restructuring. Capitalism economies have privatization policies and institutional arrangements conducive to improved company performance. Business restructuring is associated with improved company performance.
Competition policy is used to govern international cross-border merger movement which has been re-shaping the world economy during the last decade (Balcerowicz, 1994). Competition policies are standard in developed capitalist nations. Developed economies are more likely to expand to new countries. Expansion of companies from developed economies to emerging economies may result in legal, political, economic, social and ethical consequences. World Trade Organization initiated competition policy as a way of curbing adverse effects of cross-border merger movement.
Communism economies do not have competition policy. Such economies do not require competition policy because they are characterized by considerable state control over economic activity and if the government thought there was anti-competitive behavior by some corporations or industries, it mediated directly and fixed prices such as for medicines and other essential products.
Communism economies have few banking reforms. Most communism economies do not regulate their banking industry. Such centrally planned economies lack payments mechanisms; clearing systems, cheques, universal giro systems, correspondent banking, which in the Capitalist economies, have a long history in the extension of markets (Balcerowicz, 1994). In Vietnam, for example, the two features of the pre-reform banking system have persisted. Vietnam has a division between large enterprises which hold bank balances and small enterprises and individuals who can use only cash. Also, the bank balances owned by large firms are not transferable from one enterprise to another or from one city to another without obstacles. The payment system standard in communist economies is the physical transfer of cash. The system prohibits the development of the non-fragmented markets that enterprises need to produce and commercialize their products in a repetitive process that generates a return of profits and liquidity. The inefficiency of the banking sector has contributed to the growth of involuntary inter-firm debt. The payments from a purchaser to a supplier take long and unpredictable periods to clear.
Capitalism economies, on the other hand, have gone through a series of banking reforms. Economic situations such as recession and stock market bubble force the capitalist economies to come up with reforms and regulations as an intervention measure. Stock market decline promotes financial innovation and hence lead to banking reforms. For example, the stock exchange crash, successive rounds of bank failures and a general domestic and international economic decline experienced in 1929 forced Roosevelt to spearhead financial reform. Expansionary monetary policy is one of the banking reforms prevalent in capitalist economies. The most common expansionary policies include an open market purchase of government securities by the Central Bank, decreasing the discount rates of borrowing for commercial banks and reducing the required reserve ratio for commercial banks. Open market purchase of government securities helps increase the money supply in the economy by increasing the money available to commercial banks for lending thus the banks would decrease their lending rates enabling many individuals and businesses to access loans that are then used for investment. Moreover, the lowered interest rates also encourage investment.
Based on the analysis, it is apparent that the capitalist economies differ from the communist economies in many respects. They differ regarding liberalization, privatization, enterprise restructuring, competition policy, banking reform, and reform of securities markets and nonbank financial institutions. Capitalism economies are liberal and free. Communism economies, on the other hand, are rigid, closed and centrally governed by the state government.
Another observation worth making is that capitalism economies are associated with a lot of efficiencies, competition, and productivity. Communism economies, on the other hand, are associated with inefficiency, corruption, sluggish growth and lack of innovation. Most of the communist economies are shifting to the capitalist system. This change is evidenced by the rapid liberalization of the economy in Soviet nations. Russia is one of the nations that is spearheading the liberalization and privatization of its economy. The findings also reveal that capitalism economies differ from communism economies in the way they handle banking reforms.
Balcerowicz, L. (1994). “Understanding Postcommunist Transitions.” Journal of Democracy 5(4): 75-89.
Henry, M. (2014). From communism to capitalism: Theory of a catastrophe . London: Bloomsbury